Monday, April 6, 2009

I've been a student of Latin American economies for the past 40 years. From the very first time I visited Argentina in 1969 I have been struck by the persistence of poverty (of which Argentina has relatively little compared to other Latin American economies) and the constant setbacks to progress (e.g., periodic devaluations that destroy wealth) that characterize the region.

If the problems that these economies face could be boiled down to a nutshell, it would be that they have a chronic shortage of capital. That, in turn, leads to a chronic oversupply of labor, which explains why wages in Latin America are generally much lower than those in developed countries. Why the shortage of capital? Because it is not respected. Capital does not flow to economies were corruption negates the rule of law; where governments seize capital via devaluation and inflation; where debts are repudiated; where industry is nationalized; where capital is taxed at punitive rates; where prices are controlled; where private property rights are not paramount.

Latin America remains poor and backward not despite multilateral "assistance" but, in a large part, because of it.

Does it follow that poverty persists because the amounts have been just too measly to do the job? A 2006 paper titled "Foreign Aid, Income Inequality and Poverty," from the research department of the IDB itself, looked at the period 1971-2002 and found "some weak evidence that foreign aid is conducive to the improvement of the distribution of income [sic]. This finding is consistent with recent empirical research on aid ineffectiveness in achieving economic growth or promoting democratic institutions."

Economist Peter Lord Bauer called the claim that poverty is a trap that cannot be escaped without external aid an "obvious conflict with simple reality." "All developed countries began as underdeveloped," Bauer wrote. "If the notion of the vicious circle were valid, mankind would still be in the Stone Age at best."

In a recent book titled "Lessons From the Poor" researcher Alvaro Vargas Llosa echoes these insights. "The decisive element" in bringing a society out of poverty is "the development of the entrepreneurial reserves that exist in its men and women," Mr. Vargas Llosa writes. "The institutions that grant more freedom to their citizens and more security to their citizens' possessions are those that best facilitate the accumulation of wealth."

20 comments:

You say it so well in describing Latin America, I have to quote you here. Does this analysis now, unfortunately, apply to the "developed" western world, especially the US? Does this explain the recent drop in the US stock market?

"Capital does not flow to economies were corruption negates the rule of law; where governments seize capital via devaluation and inflation; where debts are repudiated; where industry is privatized; where capital is taxed at punitive rates; where prices are controlled; where private property rights are not paramount."

I suppose I should have added the obvious conclusion to my piece (to which I have alluded already in several prior posts), namely that a big part of the problem with the markets these days is that the policies of the Obama administration are very disturbingly similar to those of Argentina's President Kirchner.

Scott, let me point to the ILD (Instituto Libertad y Democracia), another NGO, but with the right attitude to one of the main problems of poverty:

"At the core of the ILD vision is the concept of “extralegality” --that ordinary, mostly poor property owners and entrepreneurs remain marginalized as long as they are deprived of three legal institutions essential for the creation of wealth:

Scott, perhaps you have heard about the "race to the bottom argument". What happens all the time is that developing countries compete with each other for foreign investments precisely by devaluating its currency which, in turn, lowers the purchasing power of its workers. So what attracts foreign capitals are low salaries, and not the opposite. In other words, "protecting" capital in Argentina means lower salaries, not higher, as you suggest. What I do think is that developing countries could do much better if developed countries were consistent with the "free trade" principles that they always endorse and reduced their huge and irrational subsidies to their local producers. This would definitely help farmers and producers in developing countries to compete on a real open market with everybody else; and I bet that if that happened you would be able to enjoy your Luigi Bosca not only in Villa Langostura but also in California, at the expense of Californian wine producers (sorry for them).

Colin: you're absolutely right. I suppose I was the victim of a freudian slip: when governments nationalize industries it is not that they are doing it for the good of the country, but rather that they are doing it for their own (private) interests: more power.

egp: I believe it was Hernan de Soto who has written a lot about the importance of property rights in fostering prosperity. I would have to agree with him and with the ILD. Without property rights there is no foundation for progress and certainly no reason for capital to be put at risk.

Cristian: you have everything backwards. Capital is never attracted to low salaries. Low salaries are the result of an absence of capital. But I agree with you that developed countries should eliminate all tariffs. Free trade is always in everyone's best interest.

Gene: thanks for the challenge. It's got me thinking, and I don't have great answers.

To begin with though, I would note that anyone living in that area of the country is free to move to any other part of the U.S., and the most motivated people probably already have. So those who remain in poverty may either not care to better their lives, or may simply like their lifestyles. That's very different from a country like Argentina or Bolivia, where emigrating is either very difficult or almost impossible. The reason we have so many illegals in the U.S. is that our immigrant quotas are ridiculously low. I should know, since my sister in law who lived in Argentina had to wait 12 years to get a resident visa for the U.S. If she had applied today, the waiting list would probably be 20 years.

Another thing I would note is that when the government tries to "help" people climb out of poverty, there are many unintended consequences, as the O'Grady article points out.

Also, "poverty" per the current U.S. definition is equivalent to "middle class" in most developing countries. So we may have an apples and oranges problem here.

I would have to agree however that there is a culture of poverty that is most likely a major factor. I have seen that in Argentina and other Latin American countries. It's similar to the class system that still exists in the U.K. Very tough to break out of the mold you're born into.

But then I think that it must be very easy for people in App. to break out, given access to TV and travel. So it is not a completely satisfying explanation.

You should check out Alvaro Vargas Llosa's book he wrote with Carlos Montaner, Guide to the Perfect Latin American Idiot. It's quite a fascinating look at some of the pathologies that influence the thinking of a significant portion of our neighbors to the south. (I say this as someone married to a Colombian.)

Scott, if the capital were attracted to high salaries, as you say, we could not explain outsourcing. The American companies that moved to Mexico or to China moved precisely because salaries in those countries are much lower than in the US. American companies benefit from low salaries and increase their margin of profit by exploiting low wage job workers. As soon as the workers in developing countries unionize, or as soon as the currency in those countries gain value, companies threaten to leave. The local governments then face a dilemma: they have to either keep wages low and their currency devaluated, so that they company stays in the country; or they have to accept the demands of local workers at the cost of losing the (poor) benefits that the American company brings to the local economy. Usually a bribe settles the issue, but I just wanted to point out how capitals and low wages get along very well.

Scott,the leverage used by government to bailout banks may be excessive according to John Hussmanhttp://www.hussman.net/wmc/wmc090406.htm I respect your sensitivity to market indicators. What if the liquidity driving them is build on the same house of cards leverage that got us into the problem

Cristian, your problem is that you are not thinking things through logically. Capital is not attracted to salaries whether they are high or low. Capital is attracted to places and opportunities where the expected return on capital is the highest given the amount of risk involved. Risk is very high in Latin America (e.g. devaluation risk, political risk, nationalization risk, corruption, etc.), so not much capital is willing to go to Latin America.

When risk is relatively low (good policies, stable currency, good government, etc.) and opportunities are plentiful (e.g., cheap, well-educated labor), then capital will flood in. Incoming capital creates new jobs, and new jobs start bidding up the price of labor.

There are only two major factors of production: labor and capital. When capital is abundant, labor becomes scarce and thus more highly paid. When capital is scarce, labor is abundant, and not well paid.

The key to progress for Latin America is to create conditions that are favorable to the entry of new capital. Without capital Latin America will languish in relative poverty.

ronrasch: As I see it, government is bailing out the banks by purchasing the securities that have dragged the banks down. We're socializing the losses, in a sense. The government sells Treasury bonds, which the market is eager to purchase, then uses the proceeds to buy toxic assets. This isn't really leverage, it's just a transfer of risk from bank balance sheets to government balance sheets.

I don't think we have a significant excess of liquidity yet. All the extra money the Fed has pumped into the system has been absorbed by huge liquidity/safe haven demand. If the Fed had overdone it, the dollar would be a lot weaker and gold would be a lot higher. That may still happen, but so far it hasn't. So the fact that a whole range of commodity prices are lifting from their lows tells me that it must be due to a recovery in demand. This isn't science, though, there is some art involved in reading the tea leaves.

It appears to be easier for folks from traditionally poverty areas to assimilate and make economic progress elsewhere than for economic prosperity to infiltrate their area. For instance I know lots of successful people who come from poverty areas. That seems to hold true whether the poverty area is a sparsely populated rural area of congested inner city. I understand China is addressing the issue by mandating the movement of millions from rural to urban, thriving, economic centers.

There does seem to be a cultural element that is content with the status quo. It is possible any outside imposition on these folks will destroy the contentment as a consequence of any change.

I also think the argument that capital is attracted to low wages is silly. Capital is attracted to returns and wages are just one element among others like property rights, efficiency, taxes, regulation, etc. If capital were solely interested in low wages, then capital would only go to places like Africa which has the lowest wages in the world. Instead, in recent times, capital has flowed quite selectively to places like Ireland, Chile, India. You don't see places like Haiti, Zimbabwe and Bolivia on that list for a reason.

Scott, I admire you for your patience and effort to educate Cristian, an almost impossible mission. But just a comment, before our country (Argentina) "suffer" from a capital flood to "exploit" our people, first argentinian capitals should stop running away from Argentina due to bad decision made by the Gov. I don't know why Cristian talks about "exploiting workers", everybody who has worked one hour in his life knows that an american or multinational company pays more than a national one in Argentina, any brazilian company pays more in Argentina than an argentinian one, so Cristian get a job!! and a life too.

PS: and they pay the payroll taxes, even government doesn't pay its own payroll taxes at all.